Give 'Em Credit

Numerous regulatory proposals aim to reverse the ebb in small-business lending. But will any of them actually work?Vincent Ryan, CFO.com | USMarch 5, 2010

How can access to capital be improved for small businesses so they can create jobs and accelerate the economic recovery? There is no silver bullet, but President Obama and Congress are floating multiple policy and legislative options to spur small-business lending.

At a House Financial Services Committee hearing last week, bankers and business owners testified that access to credit is still widely constricted for small businesses. The numbers back that up. In the Duke University/CFO Magazine Global Business Outlook Survey for the first quarter of 2010, 60% of executives at companies with less than $25 million in revenue said borrowing is much more difficult today compared with the summer of 2008, before the collapse of Lehman Brothers. By contrast, only 25% of companies in the $1 billion to $4.9 billion revenue range answered that way.

Also, a net 14% of respondents to the latest monthly survey of the National Federation of Independent Business, a small-business association, reported that loans were tougher to get in January than in their previous attempt at applying for a loan.

One proposal by the Obama administration is to take $30 billion of unused TARP money and create a Small Business Lending Fund for banks with less than $10 billion in assets. The amount of capital a bank could receive would be a percentage of its risk-weighted assets. The government would get at least a 5% dividend from the capital investment, but that rate would fall if the bank demonstrated an increase in small-business lending compared with a 2009 baseline. For every 2.5% increase in incremental business lending over a two-year period, the dividend rate would fall one percentage point. After five years, the dividend rate would increase to encourage timely repayment.

But the stigma associated with taking TARP money would discourage banks from using the fund, claimed some witnesses at last Friday's hearing. Bank of Alameda CEO Stephen G. Andrews, testifying on behalf of the Independent Community Bankers of America, said the fund would have to avoid some of the entanglements that arose with the TARP's Capital Purchase Program, in particular the issuance of stock warrants to the government and restrictions on banks' compensation and dividends.

House Small Business Committee Chairman Rep. Nydia Velázquez (D-N.Y.) was also critical of the idea, saying that "taking $30 billion and simply handing it to banks in the hopes that they will make loans is not sound policy." Instead, Velázquez wants the $30 billion sent to the Small Business Administration for development of a direct-lending program. But the SBA's own administrator, Karen Mills, admitted that the agency has neither the expertise nor the infrastructure to lend directly to small businesses, and said that those businesses would be better served if the government just improved its loan programs already in place.

The SBA and the administration want to boost the volume of government-backed SBA loans for working capital, the so-called 7(a) loan program, by permanently increasing the maximum size of a 7(a) loan from $2 million to $5 million and by continuing to temporarily guarantee 90% of each loan and waive borrower fees. The latter two measures were instituted last year under the American Recovery and Reinvestment Act.

The 90% guarantee has enabled Bank Rhode Island to boost SBA lending, says Scott Lajoie, vice president of business banking. In the first two months of 2010, Bank Rhode Island approved 48 loans totaling $5.2 million, compared with 17 loans totaling $1.9 million in 2009. "We've had a number of applications where the 10% exposure compared with a 25% exposure offset the risk associated with the credit, such as a shortfall in collateral or time in business," Lajoie says.

But some SBA lenders aren't convinced that any of the government's existing measures or proposals will turn on the spigot and lead to jobs growth. If Congress and the administration want to stimulate hiring by small businesses, they're focusing on the wrong segment, claims Tim Jochner, CEO of Superior Financial Group, a nonbank SBA lender based in Walnut Creek, California. "History shows that the smallest nonemployer firms create the most jobs in recessionary times," Jochner says. In both the 1991 and 2001 recessionary periods, firms with 20 employees or fewer had positive net job growth, while larger companies of all sizes shed jobs, Jochner says.

Congress should focus on boosting the ability of banks to underwrite loans of $100,000 and under, Jochner says. To be able to lend to the smallest companies, firms like Superior need to be able to originate more loans under the SBA's Community Express program, in which firms borrow $250,000 or less. One thing Congress could do is lift the caps on the Community Express program, which limit the total number of loans and the number of loans an individual lender can originate, Jochner says.

"I don't know of any firms with fewer than 20 employees that can afford the debt service of a $5 million SBA loan," says Jochner of the proposed increase in maximum 7(a) loan size.

SBA statistics back up claims that money is not reaching the small nonemployer firms that Jochner serves. Although Community Express lending is up at Superior Financial, nationwide only $27.9 million of Community Express loans were originated in the quarter ending December 31, 2009, compared with $67 million two years ago. Meanwhile, 7(a) loan originations last quarter increased to $3.8 billion, up 19% compared with two years ago.

Smaller loans, under $250,000, can be the toughest loans to underwrite, says Bank of Rhode Island's Lajoie, because they are generally based on the individual business owner's credit score and decisioning is automated. "We have seen time and time again where credit card companies have reduced an individual's credit limits, causing a credit-score drop that leads to a business loan decline," Lajoie says. In some cases, a second look from the underwriting team is then called for. "Some borrowers are able to repair their personal credit to the point that they are able to obtain financing within six to eight weeks," Lajoie says.